Author: Alberto Gómez Toribio

Bitcoin can do magic with money. Because Bitcoin is not just money on the Internet that allows global peer-to-peer transfers almost instantly. Bitcoin is also programmable money. And Bitcoin also allows the digitally transfer of value. That value can be 10 euros, or an asset as a ship or a house. The title to any form of assets may be entered in the Bitcoin blockchain. If to this we add the ease of transfer, we can think about the next natural evolution: Bitcoin allows smart contracts.

A smart contract is an agreement between two or more parties -people or machines- that allows the creation of conditional terms or clauses (If this, then that) and allows them to run autonomously. With the development of these applications, the Bitcoin blockchain can become a system for the creation of programmable contracts between two or more parties. Several projects and companies in the ecosystem are already working in this direction. This includes Coinffeine that allows two people to exchange euros for bitcoins with smart contracts, or Oraclize, an Italian company that offers services based on smart contracts and has followed the footsteps of Coinffeine and was established using bitcoins as social capital.

The real world in Bitcoin Scripting

The language in which these smart contracts are written is not Spanish or English, but a language called Bitcoin Scripting, and has some peculiarities. Among them, it is not possible to create clauses that refer to external conditions. This limitation of smart contracts is partly remedied by a mechanism known as Oracle, at the expense of relying on a third party. Oracles are responsible for enabling a smart contract that incorporates clauses as “only if Real Madrid wins X match” or ” only if the oil price exceeds X value at X index.” This mechanism allows that the payment of a transaction is executed only if an external condition is met. So Oracles can therefore validate clauses that refer to external information. They are the third digital party that verifies and executes certain terms of the contract. We could say it’s like a notary who has the capacity to judge and see if certain conditions are met in the external world, but they cannot touch the money.

Oracles and reversible Bitcoin payments

The term Oracle was originally defined by Alan Turing and it has been adapted to Bitcoin by Mike Hearn. “Oracle servers” are companies that provide programming scripts through which we can define a logic to validate its service, allowing us to spend the money as we agreed. Thanks to the Oracles we can get a transaction to execute only if a certain external condition is met and define conditions for cases where it is not met. In addition oracles could make Bitcoin transfers reversible. It is well known that transactions with the cryptocurrency are irreversible, but if money is committed in a smart contract rather than in a current transaction, we can make any scenario possible.

As an example, imagine you buy a pair of sunglasses on the Internet and you agree that the seller will not get your money until you confirm that you have received the package. To do this, instead of sending the money directly to the seller, you create a smart contract. Once this is done, the seller can be sure you’re going to pay because he can verify that the money is committed is locked in a smart contract pending the courier company’s confirmation that the package has been delivered. This is done the delivery consultation on its website. When the application of the courier company confirms that you have received the package, the seller asks the oracle for the verification and it signs the transaction. Automatically the payment transaction that was blocked, is released and minutes after the seller receives the money you have paid for your sunglasses.

The interesting thing about this mechanism is that a trusted third party, the oracle, has authorized the payment, but it doesn’t require having access to the escrow: the oracle does not touch the money.

When Bitcoin is combined with real-world information is when “things start to get really interesting”, said Gavin Andresen on an analysis of this topic. We will have to see how oracle projects evolve in the ecosystem, but for now, they go in the right direction. And there seems to be no turning back.

This is getting interesting!

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Over a year ago, in February 2014, I talked about oracles and much more in a speech titled “Bitcoin Protocol for Developers” at the event T3chFest.

Oraclize (currently in Beta) offers services based on smart contracts providing Bitcoin transactions based on the occurrence of some verifiable real-life event, and is based on third-parties which were already acting as oracles, such as WolframAlpha or Football API, to link them to Bitcoin transfers.

Bitcoin is a digital good that was designed as a form of money that makes sense on the Internet. It is possible to transfer from person to person easily, without intermediaries and with less commission. That is why it is increasingly popular as a way to pay on the Internet. But there are many other markets where Bitcoin, with its properties, may be the key to revolutionize some services as we know them. Sending money internationally, commonly known as remittances, could be one of these markets.

One of the main problems when money is sent internationally and is subject to a currency exchange, is to know the actual amount that reaches the destination. There are very few services that offer a fixed price. The reason for this is that when an amount of money is sent in the currency of origin, it is not converted to the currency of destination in the moment, but a few hours later or in some cases it might even take days. Because of this, the exchange rate between the currencies of origin and destination fluctuates and it is very difficult to offer a fixed price.

In many cases, the remittance processes require the identification of the recipient before receiving the payment, and it is at this time, and not before, the currency exchange is performed.

Uncertainty regarding a non-deterministic price system is not very serious if we are talking about a private person, but in the case of companies these gaps are unacceptable. Companies prefer to reduce their benefits paying for services that allow them to add certainty, and that is the purpose of many financial products.

Coinffeine’s deterministic matching system

Digital goods like Bitcoin are often praised as examples of solving problems with international money transfers for reasons that seem obvious, but that are not always certain..Cost reduction or reduction of friction to avoid identifying the parties, are two examples of this. After designing the Coinffeine’s matching system we have developed a different view: the really interesting new thing about Bitcoin remittances could be the determinism, or the ability to know precisely the money sent and received even though the system can be more expensive. A few months ago Coinffeine studied this common problem in the markets while designing the price discovery system of our platform.

Imagine a market for digital goods, such as Bitcoin or financial products, with the same user experience as a traditional market, but in which users buy and sell these digital goods between them without intermediaries, using a similar application to BitTorrent that allows them exchanging digital goods automatically and where the payments are made using payment processors such as PayPal. Welcome to Coinffeine!

If a user opens an order for one Bitcoin in a market, it is possible that even though there is sufficient liquidity there is not another user ready to to sell that amount. We can immediately think of a solution in which the user is matched with as many counterparts as necessary in order to satisfy the amount of bitcoins you want to buy or sell, but this operation is not so simple. In each operation small commissions are paid in bitcoins to the Bitcoin network for issuing transactions and in euros to the payment processor for the payment made. Although in most cases these quantities do not exceed a cent of a Euro, both depend on the number of partners required to fulfil the order.

We could be satisfied with this solution, but the truth is that this model has an unacceptable property in any market and also in the remittance market: it is not deterministic.

Since it is impossible to know the number of partners required to satisfy an order in advance, and that each match carries certain small cost, it is impossible to know what will be the exact amount of euros or bitcoins that will be received.

As in the remittance market, we are in a situation where the client needs to get a budget. But it is not possible to provide determinism because the conditions depend on the state of the market.

Coinffeine has created an algorithm to guarantee determinism

Coinffeine has solved this problem by designing an algorithm that adjusts the offer price dynamically to guarantee the user a closed budget and ensure compliance. In other words, we have succeeded in making Coinffeine a deterministic market. But how can we manage the same in a completely different market such as remittances?

Since there are several markets, or companies that allow buying and selling bitcoins in different countries, you can buy bitcoins using one of these companies in one country, send them to the country of destination and change them into local currency using a company with similar service. This makes a money transfer with currency conversion possible.

The advantage of an automatic system to perform these operations on both ends is that it is deterministic and can offer a fixed price.

Far from being a real, usable deterministic solution for remittance, the experimental use of Bitcoin today allows us to reason about using this technology in a comprehensive service based on Bitcoin. It could solve some main problems in international remittances, and help to keep the focus on the real problem: the determinism.

The same way as telephony initially, especially with mobile telephony, lacked a deterministic cost system in its services due to the price difference in calls between operators or midrange calls, remittances are now suffering the same problem. And like the mobile telephony market evolved into a deterministic costs system which created concepts such as tariffs and services with meaning and real value for the customer, it is possible that Bitcoin is the key that allows the same type of revolution in the remittance market.

Mobile payments are experiencing tremendous growth. The use of bitcoins has beeen limited so far, but services like Coinffeine can help make it much easier for users.

The mobile phone can be used as a means of payment, and operators have been trying make that happen for over 10 years.

There are countries with a failing economy where having a bank account is too expensive and inefficient, but nevertheless everyone has a mobile phone. In these countries, telephone operators have become part of the financial industry, enabling efficient payment systems that allow the transfer of mobile phone balance, known as Airtime, from person to person.

In Kenya it has become normal to pay for a coffee with Airtime using your mobile phone. This Airtime is later changed to local currency by the owner of the coffee shop. The most popular service that makes this possible is called M-Pesa and is provided by the operator Safaricom. It has over 15 million users and over 80,000 distributors in Kenya.

In developed countries like Spain electronic payments are much more efficient and the use of Airtime for this purpose is meaningless. Nevertheless, there are still some operators that allow you to send phone balance from person to person, like the popular service “Passme balance” from Telefónica Movistar.

Although it makes no sense to use phone balance to pay for a coffee in most developed countries, it can make sense for other unexplored purposes, such as the sale of digital goods.

Movistar Payments is an example of this service, allowing the purchase of digital goods with phone balance.

In Spain, the law does not allow operators to sell physical products such as cinema tickets with phone balance, but they are allowed to sell digital goods such as applications, games or even bitcoins. In fact, one of the first operators understanding the potential of the new market of digital goods is the operator T-Mobile in Poland, already offering their customers to buy bitcoins with phone balance.

But even if the sale of bitcoins in exchange for phone balance can be done in an easy way and potentially reach a large number of customers, there are several problems that would make it very difficult to offer this service.

First, if an operator wants to sell bitcoins charging the bill to the client´s phone balance, it must handle and dispose of bitcoins, and this is a problem. To maintain large deposits of cryptocurrencies is expensive, risky and it looks like it will undergo a regulation process similar to the famous New York Bitlicense, which raises the operating costs of the services with Bitcoin to the extent that it is not profitable in some cases. And to buy them on demand from a third party does not solve this problem neither.

Secondly, the latest report of the ECB on digital currency defines Bitcoin as a digital asset that can be used as money. In Spain this is exactly how Bitcoin fits into the regulation. When operators were banned to sell physical goods in exchange for phone balance, it was because it exists a need to provide certain guarantees, requesting and fulfilling a financial license. In the case of Spanish operators that decide to sell bitcoins in exchange for phone balance, it is likely that they will meet such restrictions in the future, which again would close the door of opportunity of selling this types of goods with phone balance.

Finally, and despite the fact that it already exists solutions such as Movistar Payments allowing micro purchases of digital goods such as games and apps, regulation is especially hard with operators such as Telefónica and do not allow their customers to spend more than €100 per month in this service.

Despite these problems, it is still very interesting for a telecom operator to become the main gateway to the new market of digital currencies and digital goods. And there are solutions, such as the one created by the Spanish startup Coinffeine: a P2P protocol that can be a way to explore this market.

Using the technology that Coinffeine has created, an operator that offers a similar service to the earlier mentioned “Passme balance” and that has an API, could become the largest gateway to the market of digital currencies and digital assets..

Coinffeine is an application similar to BitTorrent, which is using the money in your bank or payment processor such as PayPal, to make payments to other users automatically in exchange of bitcoins. The bitcoins are transferred from person to person, without the need to go through the banks. In this model, banks are used simply as means of payment.

What is really interesting about Coinffeine´s P2P model is that it turns the services offered by a service provider into contracts between individuals, a legal framework with many advantages for the exchange of digital goods and reducing most operative costs.

Instead of competing with banks and payment processors, Coinffeine offers them a privileged position to explore the new market of digital assets. A good proof of the interest banks have in the model that Coinffeine offers, is that a large Spanish bank already is among its partners: namely Bankinter.

The model created by Coinffeine allows banks and payment processors´ customers to buy bitcoins with their account balance, and it could work in the same way with phone operators. In this case they can enable a service that allows paying with Airtime from person to person.

Airtime is certainly a perfect means of electronic payment to purchase digital goods like Bitcoin between people or to make micro purchases, even in countries like Spain. Movistar Payments is a good example of that. But in countries like Kenya, combining Airtime and digital currencies could play an even more important role.

In Kenya, over 15 million M-Pesa clients have an inexpensive electronic means of payment in retails. But they still do not have a cheap means of payment to purchase global digital services via the Internet as an account in Spotify or Skype balance, and this is where digital currencies like Bitcoin play a key role.

Bitcoin is already accepted as payment in companies like Microsoft or Dell, and it is being made accessible to many others like Skype Credit through third party services. Bitcoin is the perfect means of electronic payment to pay and to offer digital services on the Internet in countries where Airtime is successfully used to pay in the streets.

In a country where there are more mobile phones than people, the use of Airtime as means of payment for digital goods makes sense, and it can make the telecom operators to be a key player in the new market of digital currencies.

Spain is proving to be one of the most attractive places for Bitcoin companies to set up.
Unlike what happens in other countries, Bitcoin fits in the Spanish legal framework as a digital commodity. The proof of that is that our startup could be created with bitcoins as social capital just eight months ago, something we did consciously to start a dialogue with regulators and the Central Bank of Spain.

Because of these concerns, the political party UPyD has on several occasions urged the government to start a process in which these details are studied. On Monday February 16th, I accepted UPyD’s invitation to attend a meeting at the Congress of Deputies in Madrid, where we presented our vision as experts on the regulatory process.

We attended this meeting with other experts in the field. Most notably Pablo Fernández Burgeño, expert in technology law and co-founder of Abanlex (a firm that recently won the case of “right to oblivion” against Google) and Jorge Ordovás, Director of the Department of Innovation of Means of Payment in the Digital Economy Forum.

In the meeting, Deputy Carlos Martínez Gorriagán and UPyD parliamentary technicians agreed with Coinffeine that the main use of Bitcoin is currently as a speculative vector.
To this end, and because one of the most common ways to acquire bitcoins is through traditional Bitcoin exchanges bearing cryptocurrency deposits, UPyD members were concerned about the limited guarantees that exists for users who make this kind of deposits. This is a very different scenario to the deposits of FIAT money, where a license that provides guarantees and counterparties are required.

Coinffeine explained that Bitcoin fortunately fits in the Spanish regulations as a digital commodity without being required a specific regulation. We explained that the two issues that are still unclear are how Bitcoin should be taxed and if it should be compulsory to identify the customers in companies that support cryptocurrency deposits.

The current regulation for digital commodities only brings uncertainty on these two points. These can be solved with simple questions to the Tax Agency and the SEPBLAC -Spain’s Financial Intelligence Unit (FIU) and AML/CFT Supervisory Authority-. On the other hand, a specific regulation on all legal aspects of Bitcoin could add friction to the entire industry, raise the level of complexity and requirements for the creation of new startups and jeopardize complex legal inconsistencies with other countries.

We also discussed concerns about delays and responses that do not contribute clear solutions, as in the responses obtained by Coinffeine from SEPBLAC, or the possibility that the answers are inconsistent, as the response from the Tax Agency to the question formulated by Abanlex last September 2014. The lack of answers from the administrations, have made many Spanish companies explore the possibility to set up in the United Kingdom.

The United Kingdom has been able to identify problems of inconsistency between administrations and the need to expedite responses to the Fintech industry. In October 2014, the UK finance minister announced the creation of Innovate Finance. UPyD has shown interest in the experience and decisions made in the UK to tackle the same problem that Spain is facing, and they have the intention of collaborating to replicate these success stories in Spain.

Although Bitcoin is a digital commodity in Spain, the fact is that under the current rules it is taxed with VAT. This means that companies that sell bitcoins in Spain, such as Bitcoin exchanges or ATMs, must sell at price at least 21% higher than their American counterparts. This makes this business unviable in Spain.

Coinffeine is at the moment the only legal solution that allows to buy bitcoins without paying the 21% VAT. It is all due to the magic of contracts between individuals.

A decentralized system is one in which the control or the essential parts of the system are transferred to the peripheral cores. In this way, the whole system does not depend on single points of failure to operate.

This concept is not new. Already in 2002 the paper of Petar Maymounkov and David Mazières, which would create the protocol for P2P file sharing Kademlia, explained what technical problems were solved and why it makes sense on the Internet. However, it was not until 2009 that they began to explore the mechanisms of consensus and incentives applied to decentralized systems to replace the trusted authorities. This work resulted, among other things, in the technology we know as Blockchain.

Decentralization is a concept that has become fashionable and has solved many technical problems, but few understand the business problems it also solves. Some of the Bitcoin ecosystem startups have created admirable technologies, but that do not solve problems that anyone are willing to pay for. Others are aimed at too small markets where it is difficult to create solid business models, specially if they are based on volume. Being aware of this Coinffeine, with its technology and business model, has chosen a different path.

Coinffeine has created a protocol for exchanging currencies and bitcoins between people in a secure way, using payment processors to manage payments. In the future we also intend to allow exchanges between other digital assets: next generation financial products. We understand that this is the most natural way to exchange digital assets for money, an opinion shared by regulators and experts that we have been in contact with. In this way, instead of creating a new scenario that needs to be regulated, we reuse the existing infrastructure, creating synergies with financial players on the road.

By using Coinffeine, one of the benefits is that the assets traded are always under your control. You do not need to grant us their custody at any point in the process. This means that you never have to worry about news that an Exchange has been hacked or robbed. By doing an exchange with Coinffeine, you will simply never run that risk.

Another big benefit of our technology is that it is not necessary to provide personal information. Think in Coinffeine as a tool such as BitTorrent. You download it, install it and use it. Everything keeps between you and your partner. In this regard, it is noteworthy that the payment processor you use cannot relate payments between users with operations made outside the platform.

Finally, the P2P model allows reducing operating costs of the company: since it does not withstand deposits, it is presumably not considered an MSB.

Coinffeine manages to combine the resolution of various business problems through their protocol. These problems have been solved as a consequence of what the Coinffeine protocol offers: to convert the services traditionally offered by a service provider into contracts between individuals.

In following articles I will explain the tax advantages, the operational advantages and the reduction of costs by involving contracts between individuals and also the problems that Coinffeine solves in traditional banking.